The Economy Takes a Victory Lap - July 30, 2018

Posted By Loveless Wealth Management LLC on 30 July 2018

The U.S. BEA reported Q2 Gross Domestic Product (GDP) expanded at an annual pace of 4.1%. It’s the best quarter in nearly four years, and it was fueled by a rebound in consumer spending, a jump in exports, and solid business investment.

Growth would have been stronger had it not been for an unexpected decline in business inventories, which shaved a full percentage point off GDP (U.S. BEA).

But that’s how it works – there are plenty of moving parts in the GDP equation. Some components can detract from growth; others add to growth. And the final chapter on Q2 hasn’t been written. The number will be revised two more times as more complete data are received. But the initial read is quite positive.

Looking ahead

The upbeat quarter wasn’t a surprise, as analysts had anticipated a solid rebound from Q1. The biggest question going forward is sustainability. Is the economy entering a higher orbit of growth?

Economists will agree that we should never make too much of one number. The GDP report was encouraging – no doubt about it. But one data point doesn’t make a trend. Whether or not the second half will continue to impress, well, that’s where views diverge.

So, let’s take a stab at the sustainability question. Figure 1 illustrates another way of looking at GDP. Instead of annualizing Q2’s April – June rate, which can exaggerate quarterly changes, we can review the percentage change in GDP versus the same period a year ago.

We have experienced faster growth in the economic expansion that began in 2009 (NBER data), but the data were choppier. Since the most recent low in Q2 2016, GDP has gradually and consistently accelerated, an acceleration that’s run an uninterrupted eight-consecutive quarters.

Positives—Consumer and business confidence remains elevated (Conference Board, CEO Economic Outlook, NFIB), and the impact from the tax cuts and fiscal stimulus are still in the pipeline. Negative—trade tensions have created uncertainty among some business leaders.

But let’s not discount the economic tailwinds.

Powered by tax cuts, a more confidence consumer could underpin spending in the second half of the year. A firmer economy, aided by deregulatory efforts and tax cuts aimed at boosting business investment, are supportive, though the direct impact of regulatory relief and tax cuts designed to lift the business sector could take several years to play out.

Bottom line—the surge in exports was fueled in part by a rush to export in front of tariffs on U.S. goods. It’s not likely to repeat. But then, another sharp drop in inventories, which detracted from Q2 growth, is unlikely.

Yes, there are many moving parts that contribute to the overall economy, but cautious optimism is in order.